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The U.S. is in the midst of the fourth-longest cycle in the nation\u2019s history, hitting 89 months at the end of the year. This cycle far exceeds the average 58-month cycles seen since World War II, according to Emerging Trends in Real Estate, the annual report produced by PwC and the Urban Land Institute.<\/p>\n
Now that we\u2019re in the mature phase of the recovery, we can likely expect more moderate growth in 2017, \u201cwhich has been the hallmark of this expansion that has now been seven years on,\u201d said Andrew Nelson, chief economist, USA, for Colliers International. \u201cWe never really had a break-out year, but the growth has nonetheless continued for seven years and looks set to continue.\u201d<\/p>\n
Various economic metrics exemplify this modest growth. Despite some quarterly fluctuations, annual GDP and job growth has remained low in recent years, averaging about 2 percent and 1.7 percent, respectively, according to Emerging Trends. The economy also created an average of 180,000 jobs per month in 2016, compared with an average of 229,000 jobs per month in 2015, the Bureau of Labor Statistics noted. However, a tighter labor market was the main cause for the slowdown in job creation, noted Ryan Severino, JLL\u2019s chief economist.<\/p>\n
\u201cIf we\u2019re not at full employment in the economy, we are very close to it,\u201d he said, with the unemployment rate reaching 4.6 percent by year-end 2016, the lowest it\u2019s been since August 2007.<\/p>\n
This data combined with inflation remaining below the Federal Open Market Committee\u2019s objective of 2 percent led interest rates to remain very low through most of 2016. But with a new administration in place that has announced plans to stimulate the economy through increased infrastructure spending, as well as tax and regulation reform, the Fed seemed to have some renewed optimism, deciding to raise interest rates in December for the first time in 2016.<\/p>\n
Although details remain limited, \u201cthe new administration\u2019s policy proposals have the potential to lift the economy out of the sluggish \u2018new normal\u2019 growth environment of the last seven years, at least in the near term,\u201d noted Tom Park, senior director of strategy & research for TH Real Estate, an operating division of TIAA Global Asset Management. \u201cThe perception of stronger growth and an accommodative business climate will likely support commercial real estate in 2017, as corporations plan for future growth and the space to meet expected needs.\u201d<\/p>\n
While the rate increase might be concerning for some, it was only a modest 0.25 percent, and the market has historically adjusted to them in the past, Severino noted.<\/p>\n
Interest rates already rose about 40 basis points in the weeks after the election, which was \u201ca pretty clear reaction to expectations of greater inflation and likely coming interest rate hikes,\u201d Nelson added.<\/p>\n
Higher inflation should also help balance out higher interest rates, explained Jahn Brodwin, senior managing director at FTI Consulting Inc. He noted that many market participants have already planned for a rate hike, with some borrowers today incorporating higher rates into their underwriting.<\/p>\n
\u201cThey look at what the market is going to look like when they\u2019re going to sell, and they\u2019re already anticipating that interest rates will be higher at that point,\u201d he said.<\/p>\n
Some real estate owners with short-term leases, such as multifamily, could also benefit from inflation by achieving higher rents. Office product owners, on the other hand, will likely not profit much since they tend to sign tenants to long-term leases.<\/p>\n
Foreign attraction The long-term expectation of continued economic growth and higher inflation makes U.S. real estate an attractive asset class due to its reputation as a \u201csafe haven,\u201d Brodwin noted.<\/p>\n Because the U.S. has more favorable fundamentals and greater stability than other countries, both domestic and foreign investors will continue to flock to U.S. real estate this year.<\/p>\n In the four quarters ending in June 2016, gross acquisition volume for foreign investors reached $75.4 billion, according to Real Capital Analytics. Prospects for foreign investment remain positive, although uncertainty lingers, as the new administration has discussed policies that could limit trade, which in turn could negatively impact real estate, particularly the industrial sector. But \u201cthat\u2019s still pretty speculative,\u201d Nelson noted.<\/p>\n Foreign investors will also continue to expand outside the gateway cities as they become more comfortable with the U.S. and its more risky B markets, Brodwin noted. This movement is also the result of core market prices being \u201cat or above prior peaks,\u201d Nelson added. Secondary markets with strong fundamentals may present less expensive options with more growth potential.<\/p>\n \u201cWe\u2019ll see some geographic and asset-class shifts as investors continue to evaluate risk and anticipated returns,\u201d noted Larry Heard, CEO of Transwestern. He added that while foreign investors tend to appreciate \u201cthe very largest, best gateway cities\u201d like New York, Boston and San Francisco, they may start to look at the \u201cnext five to seven cities that have healthy job growth and population in-migration.\u201d These cities include Atlanta, Dallas, Seattle and Denver, among others.<\/p>\n Despite pricing concerns in certain prime markets, though, overall pricing remains robust and cap rates are at historical lows across property types, with some upside potential, Severino noted, adding that \u201cthe spreads versus other asset classes are still pretty wide.\u201d<\/p>\n Capital convenience<\/strong><\/p>\n However, capital availability in 2017 and beyond will also in part depend on any regulatory changes the Trump administration proposes, Nelson noted. Regulatory influence has taken hold in recent years as lending institutions have adapted their strategies to incorporate the Basel III requirements and in anticipation of the CMBS risk retention rules that took effect in late December. The result has been a more disciplined lending environment, with traditional capital sources favoring a \u201crisk-off approach,\u201d the PwC report noted.<\/p>\n CMBS issuance was expected to total $67.2 billion in 2016, down 29.3 percent from the previous year\u2019s $95.1 billion and marking the first annual issuance decline since 2009, data provider Trepp reported. Projections for issuance in 2017 are only slightly improved, meaning other lenders, like life insurance companies and the housing-finance agencies, will likely see an increase in their origination volumes, the report added.<\/p>\n Donald Trump\u2019s call to relax some of these regulations\u2014including potentially repealing the Dodd-Frank Wall Street Reform and Consumer Protection Act\u2014could change this dynamic. A more relaxed regulatory environment \u201ccould indeed increase the availability of capital,\u201d Nelson noted, but it\u2019s too early to know anything for certain. No matter the legislation, though, it\u2019s clear that it will take a significant amount of time and negotiation before it goes into effect, surely beyond 2017.<\/p>\n Debt capital\u2019s disciplined approach seems to have impacted the equity side, too, especially in the institutional investor area. While institutional holdings over the three years ending in June 2016 increased by 254 assets (3.6 percent) and portfolio value rose by $169 billion (50.2 percent), this level of activity is likely to slow in 2017, as many investors wait to see what policies are proposed and focus more on rationalizing their portfolios, Emerging Trends noted. This \u201crisk-off approach\u201d is likely to favor the larger coastal and Sun Belt markets, where capital can be deployed efficiently and liquidity is most available.<\/p>\n Over the past two to three years, REITs have also been focused on \u201cless diversification and more concentration in specific markets or asset classes,\u201d noted Steven Marks, managing director & head of U.S. REITs for Fitch Ratings. Recent notable activity includes Simon Property Group spinning off its Class B mall portfolio and Vornado its D.C. office portfolio. We\u2019ll likely see further concentration through spinoff activity, Marks added, but not necessarily via mergers.<\/p>\n He explained that mergers are rarer for REITs than other corporate industrials, which often seek out consolidation when one firm\u2019s earnings are lagging and it sees growth potential in combining with another company.<\/p>\n REITs \u201ccan grow more organically through development or redevelopment, so typically the pace or magnitude of corporate merger activity is much larger than REIT merger activity,\u201d Marks said.<\/p>\n He also noted that Fitch expects to see further privatizations in the REIT space, as \u201cthe capital to fund these acquisitions or privatizations is relatively cheap, relatively plentiful, and REITs as a sector are trading at (net asset value) discounts.\u201d<\/p>\n \u201cThere will always be some level of merger activity in the real estate industry,\u201d Brodwin added, but he doesn\u2019t expect any major event to take place to accelerate it \u201cbeyond its natural rate\u2014not in 2017.\u201d<\/p>\n Private equity investors remain more risk-favorable than some other equity sources in order to generate yields, Emerging Trends noted. As a result, they\u2019re likely to pursue more value-add or opportunistic investments and direct capital toward the secondary and tertiary markets, as well as to non-core property types. There was also about $238 billion in \u201cdry powder\u201d ready for investment in real estate private funds worldwide as of June 2016, with more than half of the funds focused on North America\u2014largely the U.S.\u2014according to Prequin data.<\/p>\n \u201c(Private equity) will be fairly creative and flexible capital for 2017, filling niches that core and core-plus investors are passing over at this point,\u201d the report said.<\/p>\n As investment capital generally adopts a more cautious approach, developers are starting to show similar restraint.<\/p>\n With stricter lending standards in place, new construction across the board grew but remained muted in 2016. Markets have been absorbing new space efficiently, but certain primary markets are seeing supply begin to catch up with demand. More than 60 percent of the 105 million-square-foot development pipeline is expected to deliver by the end of 2017, according to JLL\u2019s third-quarter 2016 investment outlook, encouraging developers to be more selective about new projects.<\/p>\n This disciplined environment has also contributed to the length of the recovery and helped \u201censure we do not become dramatically oversupplied in any one product type,\u201d Heard said.<\/p>\n The multifamily sector might be the one caveat, as 2016 was the \u201chigh-water mark\u201d for development in the sector, Severino said, adding that \u201cit\u2019s hard to envision 2017 exceeding the construction volumes of 2016.\u201d Following several years of low vacancy rates, dropping from 7.1 percent in 2009 to 4.7 percent in 2015, and strong rent growth throughout the recovery, especially in gateway cities, gains are likely to moderate in the next few years, according to ULI\u2019s October 2016 real estate consensus forecast.<\/p>\n The industrial sector has also been strong throughout the recovery, largely driven by the rapid growth of e-commerce and demand for logistics and distribution centers. The sector experienced 26 consecutive quarters of net occupancy gains and annual rent growth of 5.1 percent as of the third quarter of 2016, according to Cushman & Wakefield\u2019s quarterly industrial market report. While new development will continue this year, it\u2019s likely to moderate by year-end as \u201cthe absorption rate of new product is assessed,\u201d Park said.<\/p>\n On the other hand, retail and office developers are likely to do more \u201ctactical and infill (development) for the most part\u201d because they are so tenant driven, he added. New office projects will probably be \u201cthe most challenging to secure financing for,\u201d and having a credit anchor tenant will be a prerequisite for lenders, Heard said. As Millennials age and begin moving out of the cities, you could also see a \u201cpop in select suburban office markets,\u201d Brodwin noted. He said we\u2019ll continue to see a move toward \u201csuburban downtowns,\u201d particularly those with amenities attractive to Millennials, like entertainment and access to transit.<\/p>\n Another good performer during the recovery has been the hospitality industry, driven by an improved economy and consumers having more income to spend on travel. The sector has seen record occupancy levels, but development growth in recent years has resulted in a slowdown in average daily rate (ADR), according to CBRE\u2019s 2017 hospitality outlook. The firm projects a national ADR increase of 3.3 percent this year, a 1.7 percent increase from 2016, but the pace of growth has been falling since 2014. This trend, however, varies by market. In gateway cities like New York City, a lot of new supply has resulted in absorption issues, Brodwin said. A strong U.S. dollar has also had a bit of a negative impact on tourism, but because the lodging industry is a cyclical business, it will still be in demand.<\/p>\n A continuation of strong sector fundamentals and economic growth bodes well for the real estate industry in 2017, but a cloud of uncertainty still hangs overhead. The new administration is expected to propose policies unlike those of the past eight years, so we could reasonably see a more cautious, \u201cwait-and-see\u201d approach from real estate players, especially in the first part of the year. This could result in a \u201cback-loaded year in terms of all activity,\u201d Severino noted.<\/p>\n The length of this recovery is also a concern, and while many \u201cdon\u2019t see any particular cause for alarm \u2026 eventually time runs out with these expansions,\u201d Nelson added.<\/p>\n While how much time we have left in this cycle is anyone\u2019s guess, changes the new administration has discussed that focus on stimulating the economy offer some optimism for the real estate industry.<\/p>\n \u201cIf the administration is able to put a lot of people (not reflected in the labor statistics) back to work, I think everything is going to improve when it comes to real estate,\u201d Brodwin said. \u201cWe\u2019ll need more office space, people will have more money to spend on retail, people will be buying homes or upgrading their apartments. \u2026 All of these ingredients spur the economy and make 2017 a good year for real estate.\u201d<\/p>\n
\n<\/strong><\/p>\n![\"safe](\"https:\/\/www.commercialsearch.com\/news\/wp-content\/uploads\/sites\/46\/2017\/01\/safe-haven.jpg\")
The expectation for continued strong investor interest means the availability of capital should remain high for U.S. real estate, Heard noted, pointing to the potential for appreciation and solid current yields.<\/p>\n![\"\"](\"https:\/\/www.commercialsearch.com\/news\/wp-content\/uploads\/sites\/46\/2017\/01\/seller-market.jpg\")
Slow-growth supply<\/strong><\/p>\n